WORKS CONTRACTS UNDER GST

[Srikantha RaoT]

Taxation of works contracts has been a vexed issue in India over the years leading to considerable litigation. The main reason for this has been tax jurisdiction being split between Union and States with Services being taxed by the former while goods (transfer or sale thereof) were being taxed by the latter. With works contracts being composite supply contracts involving elements of goods as well as services, identification of the amount which should suffer tax under each of the concerned jurisdictions was always an issue. This was also complicated by the fact that various States had come out deeming provisions in terms of valuation under which specific categories of works contracts could be artificially split in terms of value to identify amount to be subjected to VAT at their end where value of goods and services could not be ascertained from books individually.

These deeming rates were also at variance with deemed rate being adopted by Union for identifying the value of the service element involved in works contract execution for taxing at their end. This resulted in portion of the values being taxed by both Union as well as State under the deeming provisions in the concerned Statutes. As if complications associated with taxation of contracts involving construction, erection and commissioning works were not enough, there were also issues in taxing of software development related activities as evidenced by the matter before Karnataka High Court in IBM India (P) Ltd Vs State of Karnataka (2015 (11) TMI 328 Karnataka High Court) where software development along with consulting associated thereto were held to be services. A similar issue and stand was also involved earlier in Infosys Limited Vs DCCT (Audit 4) & Others (2015 (9) TMI 738 Karnataka High Court) in terms of development and implementation of core banking solutions for banks.

Consequently, these issues had to be sorted out at the time of introduction of the new GST law if old trends in terms of litigation had to be stopped. GST introduced across the country with effect from 1^st July 2017 has sought to address the problem. While one reason for the old problem in terms of tax jurisdiction has been taken care of due to goods and services now being taxed by both Union as well as States, the other significant point has been the idea of restricting operation of the concept of works contracts to immovable property related contracts alone. A reference to Section 2(119) of Central Goods & Services Tax Act (CGST) Act 2017 would reveal that works contract would mean a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract.

This would take us to the concept of movability or immovability of goods and this is where past judicial precedents in the context of Central Excise or Service Tax or VAT would assume significance and assist readers as the basic principle involved in applying movability test remains the same even under GST. Without being exhaustive, some of the notable decisions which could be relied on by readers are as below –

• Craft Interiors (P) Ltd Vs CCE Bangalore (2006 (10) TMI 2 Supreme Court of India): - Furniture seen to mean chairs, desks and tables which were movable in nature and not immovable relying on Mimansa Rules of Interpretation as per which popular meaning would overpower etymological meaning. Storage units, running counters, overhead unit, rear and side unit, wall unit, kitchen unit and items ordinarily immovable or not removable without cannibalizing and are not furniture.

• KEC International Ltd Vs CCE Chandigarh I (2002 (11) TMI 388 CEGAT New Delhi) maintained by Supreme Court in ( 2010 (10) TMI 1153 - SUPREME COURT ): - Cantilever assembly which comes into existence at the point of assembly of iron tubes of specified length in a cantilever design at a fixed place on the pole results from works contract and is not goods but a construction design. Beams, girders, bracket etc. become cantilever or cantilever assembly when fixed in a particular manner as a part of construction. Upon fixing on the iron mast/pole, this assembly becomes part of a permanent structure and cannot be called goods, as they cannot be moved about like any goods. They become part of immovable property.

• Triveni Engineering & Industries Ltd Vs CCE Nagpur (2000 (8) TMI 86 Supreme Court of India): -  Installation or erection of turbo alternator on the concrete base specially constructed on the land when its removal resulted in separation of steam turbine and alternator (components of turbo alternator), meant that installation or erection of turbo alternator on the platform constructed on the land would be immovable property.

• Aska Equipment (P) Ltd Vs CCE Nagpur (2006 (6) TMI 27 CESTAT Mumbai) maintained in (2009 (2) TMI 806 Supreme Court of India): - Towers put up at site which form part of earth/civil structure would be immovable property

• Solid & Correct Engineering Works & Others Vs CCE Ahmedabad (2010 (4) TMI 15 Supreme Court of India): - Setting up of asphalt drum mix plant by fixing it to a foundation with the help of nuts and bolts to provide a wobble free operation of the machine would not constitute permanent fixing, embedding or attachment in the sense that would make the machine a part and parcel of the earth permanently. Therefore, such plants were not immovable property. 

• Mallur Siddeswara Spinning Mills (P) Ltd Vs CCE Coimbatore (2004 (3) TMI 68 Supreme Court of India): - Generating set bolted on frame was capable of being unbolted and shifted from a place and was capable of being sold hence not an immovable property.

• Josts Engineering Co. Ltd Vs CCE Mumbai (2002 (8) TMI 107 Supreme Court of India): - Spray paint booth held to be immovable property as outside portions of the structure were embedded in earth and dismantling would result in damage to structure.

• Virdi Brothers Vs CCE Indore (2001 (5) TMI 918 CEGAT New Delhi) affirmed in (2006 (12) TMI 3 Supreme Court of India): - Refrigeration/cold storage plant held to be immovable property as various bought out machineries were permanently fixed to the building by concrete foundation and they formed the refrigeration plant along with the building wherein they were affixed. Some of the parts of machineries and pipes fixed therein could not be separately taken as refrigeration plant.

While we have looked at some of the decisions in the context of movability or immovability of goods, the way in which contracts are executed would also be relevant as it would alter tax impact under GST. This is owing to the fact that composite contracts/supplies in the nature of works contracts have been deemed to be services under clause 6(a) of Schedule II to the CGST Act 2017 which has to be read with Section 7(1)(d) of the Act. This would mean these contracts suffering tax at rates specified in the concerned Notifications dealing with taxation of services under CGST, SGST & IGST depending on the nature of works involved. The quantum of material used in the contract would be immaterial as entire contract would be taxed as a service.

By regarding works contracts as service, the issues which could otherwise have arisen out of the verdict of the Supreme Court in Smt. B Narasamma vs DCCT Karnataka & Another (2016 (8) TMI 636 Supreme Court) where tax liability under VAT was held to be determinable based on identity of goods at the point of accretion in works contract, have been avoided to a large extent. 

This would be different from a scenario where a supply followed by installation work is involved under a supply and installation contract. Here, the supply component would have to be taxed considering the rates applicable to goods based on their HSN Codes while service element would be taxed separately.

Whether or not a contract would be composite works contracts or one of supply or installation would have to be gauged based on facts and circumstances of each case including the terms of the contract i.e. especially nature of property involved as well as timing of transfer of ownership/title in goods. This is where due care is needed as any error in classification could result in substantial demand for the tax payer at a later date. The classification issue would also be complicated by the fact that the peak rate as well as slab rates for services and goods respectively are not the same under GST.

We could now look at some of the past judicial precedents in India which would help us in understanding the difference between a contract for sale of goods and one for work and labour also involving transfer of property in goods meriting classification as a works contract.

• Contract for manufacture, supply and commissioning of pipelines to supply water to cities from specified dams - The agreement which was clearly in two parts, namely, (i) sale and supply of PSC pipes, jointing material specials, valves, anchor blocks, etc. and (ii) the remaining part being supply of labour and services was held to be divisible and not a single indivisible composite contract for laying pipelines. Consequently, PSC pipes, jointing materials, valves, anchor blocks etc. supplied were held to be liable as supply of goods while the remainder labour and service would be taxed separately. (M/s Indian Hume Pipe Co. Ltd Vs State of Rajasthan & Others (2017 (8) TMI 1148 Supreme Court of India)).

• Contract for manufacture, supply and installation of lifts - If there are two contracts, namely, one for sale of the components of the lift by a dealer, and the other for installation, the contract for sale of components by dealer would be a contract for sale and the one for installation would be a contract for labour and service. But, a composite contract for supply and installation, has to be treated as a works contract, for it is not a sale of goods/chattel as such. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel. Therefore, it would not be appropriate to term it as a contract for sale on the grounds that the components are brought to the site, i.e., building, and prepared for delivery. (M/s Kone Elevator India Pvt. Ltd Vs State of Tamil Nadu & Others (2014 (5) TMI 265 Supreme Court))

• Supply, installation, testing and commissioning of power supply, distribution and SCADA system for Delhi Metro Rail – Provision of transformers, switchgears, high voltage cables by sourcing them from vendors designated in agreement and approved by customer and as per specifications and quantities in Bill of Goods in Bid Document can be said to be supply in relation to works contract execution as there is a clear conceivable link between contract and procurement especially where these cannot be diverted. (M/s ABB Ltd Vs Commissioner DVAT (2016 (4) TMI 534 Supreme Court))

• Sale of residential apartment/unit under development and sale agreement - When the promoter/developer enters into a development and sale agreement with the flat purchaser under which a flat is constructed and eventually sold with the fraction of land, it is obvious that such a transaction involves the activity of construction in as much as it is only when the flat is constructed that it can be conveyed, and the construction is for and on behalf of the purchaser. There is no reason why such activity of construction is not covered by the term “works contract”.  It is however to be clarified that activity of construction undertaken by the developer would be works contract only from the stage the developer enters into a contract with the flat purchaser. (M/s Larsen & Toubro Limited & Another Vs State of Karnataka & Another (2013 (9) TMI 853 Supreme Court))

• Fabrication of rolling shutters involving installation – Fabrication of rolling shutters held to be works contract as rolling shutters came into being when affixed to walls post masonry work. Where the contract is primarily one for supply of materials at a price agreed to between the parties for the materials so supplied and the work or service rendered is incidental to the execution of the contract the contract is one for sale of materials. Where the materials sought under contract have no separate identity as a commercial article and it is only by bestowing work and labour upon them, (as for example, by affixing them to the building in case of window-leaves or wooden doors and windows) that they acquire commercial identity, it would be prima facie indicative of a works contract. So also where certain materials are not merely supplied but fixed to an immovable property so as to become a permanent fixture and an accretion to the said property, the contract prima facie would be a works contract. (Vanguard Rolling Shutters & Steel Works Vs Commissioner Sales Tax UP (1977 (3) TMI 122 Supreme Court of India))

• Fabrication and installation of bottle cooling equipment at factory – Where an inclusive price was charged for the work of fabrication of the bottle cooling equipment required in the premises of the customer and for installation of the equipment as per customer’s needs, it was held to be works contract. Each bottle cooling equipment required special fabrication and had to be installed at the place selected by the customer and found suitable for installation of the unit. The contract being one for supplying for an inclusive price a specially designed fabricated unit to be assembled and installed by specially trained technicians in the premises of the customer, it was not a contract for sale of a unit or different parts of the unit as specific goods, but a works contract. (State of Madras Vs Richardson & Cruddas Ltd (1967 (5) TMI 61 Supreme Court of India)).  

One of the issues that is likely to continue under GST is the legal position to be adopted where part of the work is sub-contracted. There have been instances where the Honorable Supreme Court has taken the view that the principal contractor would not be liable on the portion of work undertaken by the sub-contractor even if there is no privity of contract between contractee and the sub-contractor. This is on account of the fact that the property in goods passes by way of accretion to the contractee which would mean there being no deemed sale/transfer from sub-contractor to principal contractor. This view has been followed in State of Andhra Pradesh & Others Vs Larsen & Toubro & Others (2008 (8) TMI 21 Supreme Court) as well as in Larsen & Toubro Limited Vs Additional DCCT & Another (2016 (9) TMI 519 Supreme Court) with both decisions being based on decision of the Supreme Court in Builders’ Association of India & Others Vs UOI & Others (1989 (3) TMI 356 Supreme Court). Considering the views taken by the Court in the context of development agreements, due care is needed in drafting clauses in the agreement with contractee/customer identifying the responsibilities of the principal contractor especially where sub-contracting is sought so that the principal contractor is not held liable for work done by the sub-contractor.

Once there is a works contract as recognized under GST law, it could also be categorized as amounting to continuous supply of service (Sec. 2(33) of CGST Act 2017) where the execution goes beyond three months with periodic payment obligations for the recipient. This would take us to Section 31(5) of CGST Act 2017 dealing with issue of tax invoice. Invoicing will have to be based on date of completion of event or date for receipt of payment where specified in the contract (i.e. on or before the concerned date) or where contract is silent in this regard, before or at the time of receipt of payment. Advances received would have to be followed by issue of receipt vouchers u/s 31(3)(d).

As far as construction related services are concerned readers may note that there are two clauses in Schedule II to CGST Act 2017 to be read in conjunction with Section 7(1)(d) of the Act. These are clauses 5(b) and 6(a) which would cover pure labour services and works contracts respectively. Clause 5 of Schedule III to be read in conjunction with Section 7(2)(a) deals with sale of land and building (other than those involving construction related service under agreement with customer). Lease, tenancy, easement or license to occupy land or rental of buildings has been covered under clause 2 of Schedule II meaning these would be within concept of supply attracting GST. This is in contrast to the view that dealing in rights pertaining to immovable property would also be akin to a transaction in immovable property itself (Salmond on Jurisprudence (12^th Edition by P.J Fitzgerald)).

This would bring into question the issue of GST liability in case of joint development agreements where the landowner gets a portion of constructed property for having allowed the builder/developer to develop his land. In this regard it would be worth noting the views of the European Court of Justice in Sani Treyd EOOD Vs Director From The Directorate “Remedies and Execution Management” for the City of Varna, Bulgaria (Case C-153/12 Dated March 21^st 2013) where it held that the tax liability to VAT on construction service would arise at the time of constitution of right to land in favour of the company undertaking construction. In our context, this would be a departure from earlier provision under service tax where liability was deferred to the time possession was transferred to the landowner through a conveyance deed. The value would have to be in tune with Section 15(4) of CGST Act 2017 read with Rule 27 of CGST Rules 2017 (i.e. open market value of service) as consideration is not in monetary terms.  

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